The cost accounting focus is not only on internal costs, but now are also on supply chain cost (costs that arise from the entire gamut of sourcing, production planning and control, and distribution) activities to begin with. So, what is supply chain cost, how is it managed with ERP software? Here is a quick overview. Read on…
What Is Supply Chain Cost?
Supply chain costs by definition include costs across the supply chain, including order processing costs, transportation-in and -out costs, material costs, product costs, warehousing, and supply chain-wide inventory and financing costs, which are described below:
- Order processing costs – Order processing costs include processing of POs for raw materials and sales orders for finished goods; order capture, validation, sourcing and distribution. The time and effort of the staff assigned to handle these orders, paperwork, searching for lost orders, order expediting, order confirmations, order pickings, billings and invoice reconciliation are all examples of costs incurred in order processing. Order processing costs are incurred by suppliers and by sellers.
- Transportation-in and -out costs – These costs comprise a large portion of supply chain costs. The measure for transportation-in costs is ratio of total transportation in costs to total material purchases. Transportation-out is measured by a ratio of transportation-out costs to cost of goods sold, sales revenue or total fleet operating costs. Transportation costs and inventory costs are generally related; for example, transportation costs can be reduced by building inventory and vice versa. Transportation optimization models that consider these different costs are used to manage transportation-in and -out costs.
- Material costs – These are easily quantifiable as prices paid for materials. However, we need to factor in quality of materials. Materials not up to standards can cause shortages due to rejections, production problems and sub-par finished product. SRM and SCM tools specially pay attention to quality metrics in deciding among approved suppliers.
- Product costs – These costs include costs of materials, labor and allocated overheads. Quality initiatives and activity-based management techniques are routinely used to control product costs and improve quality. The costs of returned products, warranty costs and after-sales service costs also need to be considered. These may be calculated as the total cost of ownership and must be minimized, since these may be borne by the producer.
- Supply chain inventory costs – One of the objectives of the usage of ERP software–particularly the Supply Chain Management is to decrease inventories throughout the supply chain, since inventories are costly. Inventory costs include financing costs, handling costs, wastage and storage costs, among other things.
- Supply chain financing costs – These costs capture funds invested in managing the supply chain. Collaborative activities must be planned and appropriate software purchased and operationalized — these activities consume money and time, along with time invested by management. Inventory carrying costs are sometimes included in this category.
Supply Chain Costing With ERP Software
Traditionally, cost accountants have been involved in determining product costs. This cycle has seen many innovations in the last few decades. Techniques such as MRP, MRP II and JIT have been successfully employed to reduce costs and improve quality. Cost accounting has also changed, and new techniques to track activities, quality and defect rates have been discovered and applied. As internal improvements stabilized, the focus of businesses turned to their trading partners—the supply chain.
Typical internal cost accounting functions supported by ERP packages include support for traditional cost accounting techniques, such as standard costing, variable costing, application of overheads and inventory valuation for external reporting purposes. Additionally, advanced cost accounting techniques, such as activity-based costing, activity-based cost management, balanced scorecard, resource-consumption accounting and customized-cost accounting techniques are also supported by ERP packages. Cost accounting simulations and what-if abilities are also included in the toolset. These are useful in optimizing supply chain costs.
In the ERP and SCM software world, cost accounting tools can be grouped under three headings:
- Traditional cost accounting tools – Traditional cost accounting tools are the tools for various methods for measuring product costs, different techniques for allocating overheads and inventory valuation methods.
- Analytical and reporting tools – Analytical and reporting tools enable simulating different cost scenarios, what-if analyses, comparison of budgets and standard costs with actual, and other reports useful to the organization.
- Proactive tools – Proactive tools permit costing in a dynamic environment, estimating costs across the supply chain and simulating planned scenarios. The primary effect of these tools on cost accounting is that cost accounting can perform both reactive and proactive roles.
Traditional cost accounting focuses on product costs and involves cost accumulation, cost allocation and inventory valuation. ERP packages support cost accumulation in real time, and costs can be observed for each batch, overhead expenses can be automatically allocated and unit product costs can be calculated. If standard cost accounting is used, then variances can be calculated at pre-defined intervals. Inventory can be valued using LIFO, FIFO or average costing methods. As materials are issued, cost of goods sold and inventory entries can be created automatically. Cost accounting calculations are linked to the financial accounting module, and inventory values can be transferred to those modules for financial reporting purposes.
Activity-based costing and activity-based management is supported by most ERP systems; Oracle has an add-on module, whereas SAP has an external partner to supply the necessary software. Managing profits centers by defining cost objects, such as products or customers, or allocation of indirect costs by identifying activities, resources and objects, is generally supported. Activity-based management can be carried out by using activity-based cost accounting data and analyzing cost drivers, activities and performance.
A number of studies have shown that for ERP, the traditional cost accounting focus on internal costs is not adequate; activity-based costing and target-costing approaches are more useful. The analytical, reporting and proactive tools support these functions.
- Target costing – Changes in product cost due to changes in sourcing, product design and manufacturing facilities can be simulated. Cost elements such as material, labor and overhead, and effects of outsourcing on product cost can be estimated and different scenarios evaluated. Overheads can be allocated using activities, resources and cost drivers, and if standard costing is used, variances can be simulated and incorporated.
- What-if analysis – What-if analyses include estimating changes in raw material costs, transportation costs and products due to changes in SCM. Cost changes due to engineering changes, new products and classic make-or-buy decisions can be analyzed and evaluated. These cost changes can be compared with the sales price, and gross margin reports can be generated.
- Reports – A plethora of reports can be generated using ERP-type software. These reports can be centered on item, time, period, cost elements, cost activities, operation or department, or can be user specified. Transaction analysis reports for these items, and comparisons between actual and standard or budgeted costs, are also available. The reports are generally supported by drill-up and –down abilities for aggregated or detailed information.
Cost accounting, managerial accounting, cost management and most other cost approaches are generally supported by higher-end ERP systems. Financial and cost data is stored in a repository or a database, and is connected to other organizational databases. Such integration permits a high level of analytical flexibility, enables sophisticated simulation capabilities and supports management techniques such as Balanced Scorecard or the SCOR model. The benefits of these systems are considerable; however, software costs, implementation problems and failure rates are also formidable.